Core Molding Technologies Inc (AMEX:CMT) generated a below-average return on equity of 6.60% in the past 12 months, while its industry returned 13.52%. Though CMT’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on CMT’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of CMT’s returns. Let me show you what I mean by this. Check out our latest analysis for Core Molding Technologies
What you must know about ROE
Return on Equity (ROE) is a measure of Core Molding Technologies’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Core Molding Technologies, which is 8.49%. This means Core Molding Technologies’s returns actually do not cover its own cost of equity, with a discrepancy of -1.89%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue Core Molding Technologies can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Core Molding Technologies’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 7.35%, which means Core Molding Technologies still has headroom to take on more leverage in order to increase profits.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Core Molding Technologies’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Core Molding Technologies’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Core Molding Technologies, I’ve compiled three pertinent aspects you should look at:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Core Molding Technologies worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Core Molding Technologies is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Core Molding Technologies? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.